1.1.4 Opportunity cost

Question 1

What is opportunity cost?

Answer 1

The value of the next best alternative foregone.

Question 2

What are some of the problems with opportunity cost?

Answer 2

• Often, not all alternatives are known
• Some factors don’t have alternative uses
• There may be a lack of information on alternatives and their costs
• Some factors (e.g. land) can be hard to switch to an alternative use

Question 3

What is a free good?

Answer 3

A good without any opportunity cost.

• For example, if you breathe air, it doesn’t reduce the amount available to other people – there is no opportunity cost.

Question 4

How does opportunity cost relate to comparative advantages?

Answer 4

The theory of comparative advantage states that countries should specialise in producing goods where they have a lower opportunity cost.

Question 5

Examples of opportunity cost

Answer 5

• If you invest £1million in developing a cure for pancreatic cancer, the opportunity cost is that you can’t use that money to invest in developing a cure for skin cancer.
• If the government spends $800bn on a war, it is $800bn they cannot spend on education, health care or cutting taxes.
• If the government build a new road, then that money can’t be used for alternative spending plans, such as education and healthcare.
• If the government offers an income tax cut, the opportunity cost is that government revenue cannot be used to finance some aspect of government spending.